AMEX Plans Active Exchange-Traded Fund

NEW YORK - The American Stock Exchange is close to filing a patent for an actively-managed exchange-traded fund, but the structure of such a fund is still a mystery, said Debbie Fuhr, a vice president with Morgan Stanley & Co. International of London, a subsidiary of Morgan Stanley Dean Witter of New York.

AMEX has developed a formula for an actively-managed exchange-traded fund and will file a patent in the coming months, Fuhr told executives attending a conference here hosted by International Communications for Management Group of Chicago.

AMEX is developing an actively-managed exchange-traded product, confirmed Bob Rendine, a senior vice president of corporate communications for AMEX. "We have a lot of intellectual capital invested in these products and we seek to do everything we can to protect that capital," he said, declining to elaborate.

AMEX attorneys are currently working on several intellectual-property cases, said Mary Joan Hoene, a lawyer with Carter, Ledyard & Milburn. Hoene's firm represents AMEX, but does not handle the firm's intellectual-property cases, she said.

Hoene had no knowledge of pending patent applications for an actively-managed exchange-traded fund. "It may be something they are keeping close to their vest," she said.

Actively-manged exchange-traded products are viewed by many in the industry as the next evolution of mutual funds and most firms are carefully watching developments in that area, according to Edgar Cha, an exchange-traded fund analyst with Strategic Insight of New York.

Still, what form such a product will take and how it will operate is unknown, said Gavin Quill, director of research for Financial Research Corporation of Boston.

"This is the financial industry's equivalent of the space program back in the 1960's," he said. Fund companies and exchanges are scrambling to develop something without knowing what it will look like, he said. "This is completely virgin territory," he said.

How an actively-managed exchange-traded fund will trade intra-day and offer the transparency of an indexed exchange-traded fund is one of the many unanswered questions, he said. With indexed exchange-traded funds, the portfolio is static and institutional investors can hedge their risks accordingly, he said.

Because the portfolio of an actively-managed exchange-traded fund will be adding and dropping securities, the portfolio manager will need to disclose to investors the market positions he is taking in order to allow investors to adjust accordingly, Quill said.

Too much disclosure of an actively-managed exchange-traded fund's holdings could pose problems, Quill said. "Maximum disclosure would make it totally transparent, but then there could be potential front-running issues," he said.

One solution might be to provide selective disclosure of the fund's underlying portfolio, he said. Under that arrangement, the fund could establish a limited range of securities that it could invest in, giving investors an idea of the position a fund might take without encouraging front-running, he said.

Another option might be to require an actively-managed exchange-traded fund to update its holdings only when it makes a significant trade or change to its portfolio, Quill said.

Yet another challenge is developing an actively-managed exchange-traded fund that offers the same tax efficiencies as an indexed exchange-traded fund, he said.